Economic Outlook – 8 April 2018

US

• The March employment report marks another solid month of gains. The shortfall in employment growth was mostly due to swings in construction and retail payrolls. Construction payrolls added 65,000 jobs in February, which was driven by unseasonably mild weather, particularly in California. March saw the return of winter weather in the Northeast and a subsequent 15,000-job pullback in construction jobs. For the quarter as a whole, builders added 78,000 jobs, which seems consistent with the improvement in single-family home construction. There is a big swing in retail trade, which reportedly added 47,000 jobs in February but then cut 4,000 positions in March. Even with all the turmoil in retailing these swings probably exaggerate the swing in retail employment, which has huge seasonal moves around Christmas and Easter.
• Two of the indicators worth focusing on are the diffusion index, which measures the share of industries adding jobs over the past month, and total hours worked, which combines the changes in employment with changes in weekly hours. Both remain remarkably strong. The diffusion index for private sector employers fell from an astounding 71.1 in February to a still outstanding 62.6. The average for the past two months is well above the average for the past few years and is consistent with what ISM surveys are showing, which are also diffusion indices.
• Both ISM indices edged back in March. The ISM manufacturing index fell 1.5 points to 59.3. Any reading above 50 means that more manufacturers are seeing improving conditions than are seeing worsening conditions. Readings around 60 are extraordinary and the string of readings around that level for the past seven months is something seen on only a handful of occasions in the past 35 years. The ISM non-manufacturing index fell 0.7 points to 58.8, again remaining at an extraordinarily high level. Strength in the ISM indices suggests that economic growth has broadened, lifting more industries and more regions than previously in this recovery. As a result, economic gains should be more durable and better able to withstand the blustering winds emanating from the still-intensifying trade debate with China.
• After China retaliated in the wake of a fresh round of tariffs imposed on it early this week, US president Donald Trump instructed the US Trade Representative to consider an additional $100 billion in tariffs on the country’s products, though in a statement, the president said the US is still prepared to negotiate with China. Investors hope that the two sides can reach an agreement during the months-long period that it will take for the tariffs to work their way through the US bureaucracy and that the tit-for-tat levies are merely negotiating tactics. On Tuesday, China’s president, Xi Jinping, is scheduled to speak at the annual Forum for Asia on the steps China is taking to open domestic markets to foreign competition. Investors will watch the speech closely to see if the country takes a conciliatory or confrontational posture as it navigates an increasingly turbulent trade relationship with the US. Meanwhile, it appears that the United States, Canada and Mexico are close to agreeing on a revamp to the North American Free Trade Agreement. Negotiators hope to announce a preliminary deal ahead of the Summit of the Americas in Peru next week.
• US Federal Reserve Board governor Lael Brainard said in a speech this week that valuations in a broad set of markets appear elevated relative to historical norms, even when taking the recent uptick in volatility into account. Asset prices could be particularly vulnerable to any unexpected economic shocks given tight valuations, she said, saying also that despite elevated valuations, overall risks to the financial system appear moderate. Brainard underlined that while US trade policy is a material uncertainty for the economy, there is a need for a gradual tightening of monetary policy.
• The major benchmarks ended lower after another week of significant volatility. Consumer discretionary and energy stocks fared best, while health care, industrials, and technology shares lagged. President Donald Trump continued his Twitter attacks on Amazon.com, but Amazon’s stock recouped a portion of its recent losses at midweek before falling again in Friday’s broader sell-off. The week was also notable for the initial public offering of streaming music company Spotify. Heightened trade tensions between China and the US continued to dominate sentiment during the week. Stocks sold off sharply on Monday, following China’s announcement that it would retaliate on US aluminum and steel tariffs with $3 billion in new tariffs of its own, targeting roughly 130 U.S. products and concentrated on agricultural exports. On Tuesday, the US further upped the ante, outlining a list of $50 billion in proposed tariffs on 1,300 Chinese products, and China responded on Wednesday with its own $50 billion list of tariffs on US soybeans, cars, and aircraft.
• The yield on the 10-year Treasury note rose following the employment report, although it fell back later on Friday amid the heightened trade rhetoric and ended the week modestly higher. Meanwhile, a lack of issuance continued to be a driving factor in the municipal market, with the week’s new issuance calendar dwarfed by underlying demand in the market.
• In the US, CPI core numbers are due for release on Wednesday. The numbers from March are expected to remain unchanged at 0.2% month-on-month, which translates into 1.9% year-on-year (up from 1.8%).
• The FOMC minutes from the March meeting are due on Wednesday. As expected, there were no major changes in the statement but it still signalled that the Fed is more confident that inflation is heading higher. However, the minutes might provide clues on the timing of rate hikes.

EU

• In the Euro area, inflation edged higher to 1.4% year-on-year but remained below the ECB’s target of below 2.0% while unemployment rates ticked lower to 8.5%. Inflation remained subdued as evident in a weak retail sales but is expected to pick up over time given higher energy cost in the near term which may reaffirm view that the ECB is preparing for a withdraw of its stimulus programme.
• The economic recovery in Europe continued to strengthen, according to some measures. Unemployment in the 19 countries that use the euro fell to its lowest level since December 2008, according to statistics agency Eurostat. But inflation remains well below the European Central Bank’s target of just under 2.0%. Wage growth was also dull. Weak domestic demand caused German industrial production to fall 1.6% in February versus expectations that it would rise 0.2%. Basic resources, including mining and metals stocks, and technology shares lagged the rest of the European market. Consumer staples and utilities stocks performed comparatively well, as investors were attracted to these more defensive stocks, which generally are less volatile during times of economic uncertainty.
• European stocks endured a volatile week as trade hostilities between the US and China prompted investor sentiment to vacillate between optimism and pessimism about the prospect of a global trade war. The pan-European STOXX 600 Index ended the week higher due to a rally on Thursday that produced the biggest one-day %age gain in nearly two years, according to FactSet data. Thursday marked the first day of equity gains for the week, as investors seemingly were comforted by signs that the US and China trade tensions were beginning to ease.
• There are no market movers for the euro area this week. The most interesting is the ECB minutes from the March meeting. At the meeting, the ECB removed the QE flexibility. The minutes are unlikely to provide new insight about the timing of the next step in the normalisation process.

UK

• The UK Services PMI fell to 51.7 in March from 54.5 in February. This was a much weaker outcome than the consensus expectation of 54.0. The PMI Composite was also lower than expected in March at 52.5, down from 54.5 in February. The consensus expectation was 54.0. The services sentiment was burdened in March by weaker growth in order intake, as well as by business activity and employment. The latest expansion in business activity in the services sector was the weakest for over one-and-a-half years according to the survey. Survey respondents noted that unusually bad weather had been a key factor holding back business activity growth in March. However, in addition to bad weather, survey respondents cited subdued consumer demand and Brexit-related uncertainty. Employment numbers increased at only a moderate pace in March, with the rate of job creation the slowest seen so far in 2018. According to the survey, inflationary pressures picked up again in March, but were still running well below the peaks seen late last year. As such, the downward trend in price pressure appears to be intact. Looking ahead, service sector firms were optimistic about their prospects over the next 12 months. However, the degree of positive sentiment eased to its lowest since June 2017. Heightened economic uncertainty was cited as a key factor weighing on business confidence.
• UK retail sales suffered their second worst monthly drop on record, since the British shoppers failed to venture outdoors because of an unusual amount of snow in March. Retail stocks were also laggards.
• In the UK, focus this week will be on industrial and manufacturing production data and construction output, which should add further insight on the current activity in the UK economy. Both industrial and manufacturing production data are expected to show modest monthly increases in February, indicating that activity is slowing somewhat.

China

• The official manufacturing PMI index increased more than expected and by more than a full index point from 50.3 in February to 51.5 in March. On the contrary, manufacturing PMI from Markit unexpectedly fell from 51.6 in February to 51.0 in March. The official index rebounded from a drop of roughly the same size in February, and the rebound thus confirms that the February drop likely was a distortion due to the timing of the New Year holidays. Markit usually seems to better adjust for the New Year than the official statistical bureau, hence the trend seems downward. That would be in line with the view that overall economic growth should slow gradually ahead. The construction boom is very likely over due to the many measures taken by the authorities to avoid speculation and dampen the lively housing markets. The authorities are also eager to dampen overall credit growth and, in particular, shadow banking activity, and that, along with the measures to combat air pollution and the escalating trade war with the US, will inevitably weigh on economic growth ahead.
• Chinese PPI and CPI inflation are the most important items to watch. A small further decline in PPI inflation from 3.7% year-on-year in February to 3.6% year-on-year in March (consensus 3.2% year-on-year) seems in order, based on a moderation in commodity price inflation. CPI inflation moved up to 2.9% year-on-year in February but the increase was due partly to the timing of Chinese New Year and the inflation rate is set to decline in March to around 2.5%.

Sources: Wells Fargo, T. Rowe Price, Handelsbanken Capital Markets, Hong Leong Bank, Danske Bank, MFS Investments.